The world economy is being buffeted by several shocks. The United Kingdom, like most OECD economies, is in a deep recession. House prices are falling after an extended period of large increases which left many households over-extended. Financial conditions are tight, and the financial market crisis has threatened the stability of the financial system. External conditions are also highly unfavourable. The recovery is likely to be slow and unemployment is expected to climb significantly. Both monetary and fiscal policies have eased to cushion the severe downturn with the policy rate now at historically low levels and quantitative easing measures under way. The authorities have also moved quickly to introduce a wide range of measures to stabilise the financial system.

In the short term, the policy priority must be to further improve conditions in credit markets. This is essential for reviving the economy. Alongside this, policy should aim at damping the severity of the downturn and its impact, particularly on the labour market. Policy actions that could undermine longer-term objectives need to be avoided. Over the medium term, fiscal consolidation needs to be underpinned by an effective fiscal framework and financial market regulation and supervision needs to be overhauled. The financial crisis and its consequences are likely to lead to a permanent fall in the level of potential output. Therefore, measures to raise long-run living standards will have renewed importance.

Restoring sound public finances and improving the fiscal framework. As in most other OECD countries, the fiscal situation has deteriorated sharply. Room for additional fiscal stimulus is limited, although further targeted measures may be warranted if prospects weaken further. To maintain credibility and promote growth, the government should continue to develop a comprehensive plan to rein back debt to a prudent level once the recovery has taken hold. Any reformulation of the fiscal rules should provide for spending discipline and be forward-looking.

Improving the efficiency of the health care system. Since 2000, many aspects of the health care system have been reformed. A large increase in spending has improved outcomes in many respects, but measures of productivity of health care provision fell up to 2005, although these measures are not yet comprehensive, and other measures of NHS value for money have improved. Reforms need to continue and indeed accelerate to ensure that the NHS remains sustainable as the growth of spending slows and in the long term as the population ages.

Putting in place a financial market framework that promotes stability. A well regulated and supervised financial system is necessary to promote long-term growth and macroeconomic stability. During the credit cycle, some UK banks became heavily reliant on wholesale funding and lent on a large scale, which led to substantial losses. Stronger banking regulation is required and supervision needs to become more effective. The framework to manage systemic risks needs to be developed further.

Assisting labour market adjustment and promoting productivity growth. The unemployment rate could reach close to 10% by 2010. Over the last few years, with low unemployment levels, spending on active labour market programmes has been comparatively low. As unemployment has risen significantly, the government’s further policy initiatives in this area are warranted, particularly those focused on the younger unemployed. The proportion of people on disability pensions remains high. The Pathways to Work scheme is now being extended across the country and should be expanded to the stock of disability benefit recipients, as the government plans to do from 2010 onwards. More also needs to be done to promote productivity growth. The priorities should be the continued improvement of the land-use planning system, providing public infrastructure, and to raise training and education levels further.